FINANCE: U.S. Firms Pay Dividends Early to Avoid Tax Increases

This is the season to pay dividends. At least that is what over 100 major U.S. corporations are doing this December. There are two main reasons for this.

First successful companies have had over four years since the recession to build significant cash on their balance sheets. This is often the outcome after reducing staff and inventories causing lower overhead and increased cash flow. With the uncertainty of what the corporate tax rates will be in the future and the very slow recovery, many Chief Financial Officers have been reluctant to invest outside their own firm. Hence the balance sheet looks good and profits have been steady as well. This allows for the availability of extra cash to either increase dividends or pay them early.

The second reason is the impending Fiscal Cliff. Corporations that would normally pay the fourth quarter dividend after January 1st can avoid the unknown tax rates for 2013 by paying the dividend a few weeks early and pushing that income into 2012 tax rates. Next year the top tax rate on dividends could almost triple from 15% to nearly 45% if tax code is not revised before the Bush era tax cuts expire.

Many companies such as Wal-Mart, Cisco, Dillard’s and Las Vegas Sands have announced early dividend payments and several set a bonus dividend for this December.

Prior to 2003 dividend income was taxed at ordinary income rates and could be as high as 39.6% federal plus the appropriate state tax, which in Colorado is another 4.65%. The qualified dividend rate was cut in 2003 to 15% capped at the lower capital gains rate. Both types of investment income are subject to increases in the future.

While there are many opinions about what will happen on Capital Hill in the next few months, companies flush with cash are not taking any chances. Markit reports that more than 100 corporate giants are paying earlier and in some cases higher dividends compared with the average of 31 companies paying December dividends in prior years.

Many of these companies have significant portions of their shares owned by employees and family members, hence helping out those folks on their personal tax returns as well. By realizing more income in 2012 when tax rates are known, some wealthy business owners could be avoiding a potential higher tax rate in future years.

Small business owners can do similar tax planning this year by pushing more income into 2012 if possible. Besides the sunset of the current tax code, wealthy taxpayers may also be faced with the additional 3.8% health care act tax on investment income and sales of appreciated assets.

Patricia Kummer has been an independent Certified Financial Planner for 26 years and is President of Kummer Financial Strategies, Inc., a Registered Investment Advisor in Highlands Ranch. She welcomes your questions at www.kummerfinancial.com or call the economic hotline at 303-683-5800.Any material discussed is meant for informational purposes only and not a substitute for individual advice. Contact your tax advisor for your specific tax questions.